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Royal Dutch Shell - cash booms as derivatives muddying the water

Nicholas Hyett, Equity Analyst | 28 October 2021 | A A A
Royal Dutch Shell - cash booms as derivatives muddying the water

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Royal Dutch Shell reported total revenue in the third quarter of $61.6bn, up 37.7% year-on-year. That comes despite a modest decline in production and reflects a significant increase in oil & gas prices.

However, profits fell from $177m a year ago to a $988m loss this quarter, as derivative losses in the Integrated Gas business more than offset progress in Upstream oil & gas production. Excluding the effect of these and other derivative movements, underlying profits more than tripled to $4.1bn, while underlying operating cash flow reached a record high.

The company announced a dividend of $0.24 per share, up 44.1% year-on-year although in line with the dividend announced last quarter.

The shares fell 1.0% in early trading.

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Our view

The yoyoing of the oil price over the last 18 months has made Shell's results difficult to keep track of. However, we think the underlying trend is positive thanks to the fundamental strengths of the group's assets.

With oil trading at $82.55 a barrel, close to the highest it's been in over 5 years, these were always going to be good times for oil majors. Shell reported record operating cash flows in the third quarter - despite production disruption caused by hurricanes in the Gulf of Mexico and an increase in operating expenses. Results may have been a touch behind market expectations, but the direction of travel is clear.

The cash windfall couldn't come at a better time for the group. Not only has it allowed it to slice tens of billions off net debt, but it's funding an increase in capital expenditure as Shell invests in new gas fields as well as low carbon alternative fuels like hydrogen. Disposals have lent a hand too, with the imminent sale of the group's Permian shale fields expected to shore up the balance sheet, while also funding a $7bn share buyback.

We suspect operating expenditure will tick up again from here, given the group's increased environmental commitments. Alongside results Shell committed to halving emissions from operations by 2030, and that either requires significant investment in new technologies, or a further restructuring of the current business - neither of which will come cheap.

Whatever happens, Shell will remain an oil and gas giant for decades. We suspect the concern is that oil & gas groups in general risk the fate suffered by tobacco companies. With investors turning their nose up at tobacco stocks at any price, valuations in the cigarette industry have sunk to what would ordinarily be considered unsustainable lows - the two UK giants trade on PE ratios of 7.5 and 6.4 - with little to no prospect of recovery in our view. If big oil can't convince investors it's making the right moves it risks the same fate.

We're not immediately concerned Shell will end up in the ethical waste bin. But projects to keep the group moving in the right direction risk eating into cash flows - especially as many of the newer technologies the industry is exploring are untested at a global scale.

Fortunately, Shell can afford to dabble - always assuming, of course, that the oil price doesn't catch a cold. Market conditions across all the divisions are improving, there should be scope for more cost savings and production increases. That should drive profits and free cash higher.

The prospective yield has come back a long way in recent months, a reflection of the improved cash position, and currently stands at 3.4%. But with plenty of other demands on cash, growth might be thin on the ground.

Shell key facts

  • Price/earnings ratio (next 12 months): 8.4
  • Ten year average Price/earnings ratio: 11.5
  • Prospective dividend yield (next 12 months): 3.4%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Third Quarter Results

The Integrated Gas business reported a loss of $3.2bn, with underlying profits after derivative movements are stripped out of $1.7bn, more than doubling year-on-year. That reflects an 11.1% increase in production, as the Prelude LNG platform restarted production as well as higher prices. Underlying operating cash flow from the division rose nearly tripled to $7.8bn, with capital expenditure up 24.7% to $1.3bn.

Upstream reported profits of $1.3bn, with underlying profits of $1.7bn, up from an $884m loss 12 months ago. Production fell 5.5% year-on-year, negatively impacted by the effect of Hurricane Ida, however this was more than offset by higher oil & gas prices. The division reported underlying operating cash flows of $5.9bn more than twice last year's level, with capital expenditure rising 20.6% to $1.5bn.

The Oil Products division reported $1.4bn of profit, or $1.2bn on an underlying basis, down 27.9%. That reflects lower refinery intake, partly due to Hurricane Ida. Chemicals reported profits of $357m, or $395m on an underlying basis, up 74.0% year-on-year. That improvement was despite significant disruption caused by Hurricane Ida, and reflects improved market prices. The division reported underlying operating cash flows of $684m, up 40.2% year-on-year, with capital expenditure of $1.1bn up 77%.

Shell reported free cash flow of $12.2bn, up 61.4% year-on-year, or $11.1bn excluding the effects of acquisitions and disposals, up 65.4%.

The group finished the year with net debt of $57.5bn, down from $73.5bn a year ago. That reflects the significant organic cash flow delivered in the year, as well as significant disposal proceeds.

In September the group agreed the sale of its Permian business for $9.5bn, with the proceeds to fund a $7bn return to shareholders post completion in 2022.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.